Wednesday, 13 January 2016

Is mainstream academic macroeconomics eclectic?

For economists, and those interested in macroeconomics as a
discipline

Eric Lonergan has a short little post
that is well worth reading. Not because it is particularly deep or
profound, but because it makes an important point in a clear and
simple way that cuts through a lot of the nonsense written on
macroeconomics nowadays. The big models/schools of thought are not
right or wrong, they are just more or less applicable to different
situations. You need New Keynesian models in recessions, but Real
Business Cycle models may describe some inflation free booms. You
need Minsky in a financial crisis, and in order to prevent the next
one. As Dani Rodrik says,
there are many models, and the key questions are about their
applicability.

If we take that as given, the question I want to ask is whether
current mainstream academic macroeconomics is also eclectic. (My
original title for this post was can DSGE models be eclectic, but
that got sidetracked into definitional issues, but from the way I
tend to define things it is the same question.) My answer is yes and
no.

Let’s take the five ‘schools’ that Eric talks about. We clearly
already have three: New Keynesian, Classical, and Rational
Expectations. (Rational Expectations is not normally thought of in
the same terms, but I understand why Eric wanted to single it out.)
There is currently a huge research programme which aims to
incorporate the financial sector, and (sometimes) the potential for
financial crises, into DSGE analysis, so soon we may have Minsky too.
Indeed the variety of models that academic macro currently uses is
far wider than this.

Does this mean academic macroeconomics is fragmented into lots of
cliques, some big and some small? Not really, in the following
important sense. I think that any of this huge range of models could
be presented at an academic seminar, and the audience would have some
idea of what was going on, and be able raise issues and make
criticisms about the model on its own terms. This is because these
models (unlike those of 40+ years ago) use a common language. The
idea that the academic ranking of economists like Lucas should
reflect events like the financial crisis seems misconceived from this
point of view.

It means that the range of assumptions that models (DSGE models if
you like) can make is huge. There is nothing formally that says every
model must contain perfectly competitive labour markets where the
simple marginal product theory of distribution holds, or even where
there is no involuntary unemployment, as some heterodox economists
sometimes assert. Most of the time individuals in these models are
optimising, but I know of papers in the top journals that incorporate
some non-optimising agents into DSGE models. So there is no reason in
principle why behavioural economics could not be incorporated. If too
many academic models do appear otherwise, I think this reflects the
sociology of macroeconomics and the history of macroeconomic thought
more than anything (see below).

It also means that the range of issues that models (DSGE models) can
address is also huge. To take just one example: the idea that the
financial crisis was caused by growing inequality which led to too
much borrowing by less wealthy individuals. This is the theme of a
2013 paper
by Michael Kumhof and colleagues. Yet the model they use to address
this issue is a standard DSGE model with some twists. There is
nothing fundamentally non-mainstream about it.

So why is the popular perception so different? Why do people talk
about schools of thought? I think there are two reasons. First, while
the above is true in the realm of academic understanding and
discourse, it does not carry over into policy. When it comes to
policy, we get to learn which models academic think are applicable to
particular policy problems, and here divisions can be sharp. Second,
there are plenty of people outside academia who have a public voice
about economics (and generally a policy orientation), and they often
do see themselves as school followers.

In terms of working practice rather than the hot end of macro policy
decisions, most academic macroeconomists would regard themselves as
eclectic in terms of the kind of work they are prepared to spend an
hour or two seeing presented. But this view, and the common language
that mainstream academics use, leads me to the No part of the answer
to my original question. The common theme of the work I have talked
about so far is that it is microfounded. Models are built up from
individual behaviour.

You may have noted that I have so far missed out one of Eric’s
schools: Marxian theory. What Eric want to point out here is clear in
his first sentence. “Although economists are notorious for
modelling individuals as self-interested, most macroeconomists ignore
the likelihood that groups also act in their self-interest.” Here I
think we do have to say that mainstream macro is not eclectic.
Microfoundations is all about grounding macro behaviour in the
aggregate of individual behaviour.

I have many posts where I argue that this non-eclecticism in terms of
excluding non-microfounded work is deeply problematic. Not so much
for an inability to handle Marxian theory (I plead agnosticism on
that), but in excluding the investigation of other parts of the real
macroeconomic world. (Start here,
or type microfoundations into this blog’s search box and work
backwards in time.) But for me at least this as a methodological
point, rather than anything associated with any school of thought.
Attempts to link the two, which I think many people including myself
have been guilty of, just confuses.

The confusion goes right back, as I will argue in a forthcoming
paper, to the New Classical Counter Revolution of the 1970s and
1980s. That revolution, like most revolutions, was not eclectic! It
was primarily a revolution about methodology, about arguing that all
models should be microfounded, and in terms of mainstream macro it
was completely successful. It also tried to link this to a revolution
about policy, about overthrowing Keynesian economics, and this
ultimately failed. But perhaps as a result, methodology and policy
get confused. Mainstream academic macro is very eclectic in the range
of policy questions it can address, and conclusions it can arrive at,
but in terms of methodology it is quite the opposite.

36 comments:

" there is no reason in principle why behavioural economics could not be incorporated"

there is no reason in practice:

http://pages.stern.nyu.edu/~xgabaix/papers/brdp.pdf

This paper proposes a tractable way to model boundedly rational dynamic programming. The agent uses an endogenously simplified, or “sparse,” model of the world and the consequences of his actions and acts according to a behavioral Bellman equation. The framework yields a behavioral version of some of the canonical models in macroeconomics and finance.In the life-cycle model, the agent initially does not pay much attention to retirement and undersaves; late in life, he progressively saves more, generating realistic dynamics. In the consumption-savings model, the consumer decides to pay little or no attention to the interest rate and more attention to his income. Ricardian equivalence and the Lucas critique partially fail because the consumer may not pay full attention to taxes and policy changes. In a Merton style dynamic portfolio choice problem, the agent endogenously pays limited or no attention to the varying equity premium and hedging demand terms. Finally, in the neoclassical growth model, agents act on a simplified model of the macroeconomy; in equilibrium, fluctuations are larger and more persistent.

"“Although economists are notorious for modelling individuals as self-interested, most macroeconomists ignore the likelihood that groups also act in their self-interest.” Here I think we do have to say that mainstream macro is not eclectic. Microfoundations is all about grounding macro behaviour in the aggregate of individual behaviour."

I am not sure about this. We are all familiar with the shortcomings of representative agent models, but if you think of a simple heterogeneous representative agents model (so you might have entrepreneurs, incumbent capitalists, high and low skilled workers etc. each modelled in a single representative agent way) how far is that from a set up that models groups pursuing their own interests?

I haven't thought this through, but perhaps the methodological problem that constrains mainstream macro in a way that means it cannot really get at these ideas is not the unit of analysis (individual or group) but the difficulty of modelling collaborative strategic behaviour, and incorporating the influence of group interests on policy choices? Isn't that more what Marxists etc. are getting at, that the rich influence policy strategically to oppress the masses (or whatever, this is just a sketch).

And also, perhaps, a preference for using models to examine one idea at a time, as opposed to trying to have all sorts of things going on at once and interacting. Which is again perhaps what an eclectic approach might try to cater for. My impression is that when mainstream methodology tries to take on too much at once, it quickly becomes unconvincing and impossible to discern what is really driving the results. If I was a famous economist I'd like to coin my own 'law' = the more realistic you try to make your model the less convincing people will find it. Every feature you add to a model just adds another thing to complain about.

"if you think of a simple heterogeneous representative agents model (so you might have entrepreneurs, incumbent capitalists, high and low skilled workers etc. each modelled in a single representative agent way) how far is that from a set up that models groups pursuing their own interests?"

Completely far. Each constituency is still an aggregate of independent individuals (e.g. they are typically price-takers, etc.). No element of group co-operation is introduced.

The best you can say is that such a model, if badly done, might introduce behaviours that can't in fact be derived from additively aggregating the corresponding behaviour on the part of multiple agents operating in parallel.

Such a model might unsystematically mimic a few arbitrary aspects of some conceivable kind of group action, but only by mistake and not in such a way as to produce any useful result concerning such action, still less one that is likely to be recognised as such and accordingly 're-purposed'.

Tim - I am not convinced. Rather than having no element of group cooperation, if you model a group as a single representative agent, I think you could say that's rather like assuming an extreme of perfect cooperation within the group, which acts as one. I repeat that I think the real difficulty is introducing strategic behaviour.

Give me an example of the kind of group action which you think could not be modelled using a representative agent, by which I mean examples of groups acting to achieve some end. I do not mean issues around sustaining cooperation within groups or modelling how groups arrive at decisions etc. which obviously cannot be addressed (because you are in effect assuming perfect cooperation, perfectly aligned objectives among group members).

"the real difficulty is introducing strategic behaviour"I don't see any need to disagree with that.

As for why a representative agent model is not a model of a co-ordinated group (even the bizarre but conceivable edge case of a perfectly coordinated one) I would just be paraphrasing what I've already written above.

I am very far from competent to comment on your principal points but I would like to underline one key issue relating to modern models:

You say "Models are built up from individual behaviour." I would assert that no, they are built up from certain assumptions about individual behaviour - and these assumptions limit in not always forseeable ways the predictions or findings of the models.

Incorporating a concept of group, as opposed to individual, behaviour may help. But a lifetime outside of the academy, often looking in and occasionally purchasing research from inside convinces me that models, like cost-benefit analysis and many other analytical tools, are ways of grounding your assumptions and working through - more or less rigorously - to their consequences rather than tools to describe and predict the workings of the real world.

You and others have noticed the divide that happened a few (many?) years ago when internal consistency and 'grounded' assumptions became more important for publication and career advancement than accuracy or realism of the model. There are signs of a return to realism in academia but in line with our favourite saying of the Master, the people leading this return are not yet sufficiently 'long dead' to influence the current generation of practical policymakers.

Until model findings can be validated by real world evidence and observation, as would be taken for granted in 'hard' sciences, and such validation is rated above elegance and consistency in the publication and preferment market, economics as a practical guide to policymakers will be neutral at best and downright dangerous at worst, tending always to justify the worst aspects of modern society.

SWL should start with the need for economics, before anything else, to understand the financial system and its ability to create credit/money out of nothing - so called endogenous-money.

Every time I see Savings = Investment, a post-hoc reportage from the Natl Income and Products Accounts (NIPA), I hope that others will understand that a lot of the money counted as Investment has in fact come from the financial entities who have the privilege to create credit out of nothing (that is; the 'capital' does NOT depend on the loanable funds from personal savings).

Which means, of course, that Personal Savings is not the same as the NIPA and economist's use of the term 'savings' -- and it is also not the source of Investment capital so much because this retrospective accounting program (and its embedded identity-definition of savings and investment), NIPA, ought not be used to justify certain political economic views.

It does not, for instance, mean that it is critical to have tax policy that favors capital in order to obtain investment levels needed by society (again, this is because Investment funds are created out of whole cloth in large measure, and do not come from Personal Savings).

I think this is an interesting example. I think too many economists did have in the back of their mind a kind of money multiplier world, and I think heterodox economists have been right to call them out on this. (The claim that this issue undermines all mainstream macro is silly, though.) Now mainstream economists are beginning to explore this issue e.g.

And where are heterodox economists in this debate. Nowhere, in part by choice. I would suggest that in 10 years time, when this issue is fully incorporated into the diversity that is mainstream macro, heterodox economists will still be claiming that mainstream economics ignores this point.

Interesting that you point to the Kumhof paper as an example of DSGE flexibility. I've seen other supporters of the academic mainstream that cited that very same paper. Is that just coincidence , or is Kumhof a rare exception , suitable for framing , as needed ?

Notable as Kumhof may be , it maintains the mainstream bias. Kumhof postulates that the output decline that follows the inequality/debt process is a result of destruction of capital stock , a nice supply-side touch , I suppose , but not matching real-world events. I don't recall headlines recounting the widespread melting down of capital stock for scrap , but maybe I just missed it.

On the other hand , non-mainstream authors like Fazzari et al , using non-mainstream , demand-based Keynesian models , use the same data as Kumhof and propose a plausible mechanism for the collapse in output that matches real-world outcomes without assuming capital stock terrorism. Instead , they rely on differential "marginal propensities to consume" , which , to the academic mainstream , is the worst kind of economic terrorism. Thus Kumhof gets all the pointers , while Fazzari gets squat , and both "popular perception" and academic perception get reinforced , as one should expect , in opposite directions.

I'd imagine that since the crisis it's become more acceptable for the mainstream tribe to discuss MPC. The blogosphere discussion alone would have forced the issue , if internal deliberations failed to do so.

The question that remains is where are all the pre-crisis studies comparable to those of Kumhof and Fazzari ? Increasing income and wealth concentration at the top has been a decades-long process , so surely concerns about sustainability of demand would have been expected to generate a robust research program exploring the issue. But no. Instead , as late as 2004 , we had Lucas feeling perfectly comfortable in warning the troops about the "poisonous" impact of distributional considerations on the study of economics. Most of the troops took that warning to heart , but there were some exceptions , of course. Now , after the crisis , those exceptions are becoming more common , but the supply-side force is as strong as ever , and financial "frictions" the most common excuse for our troubles. Just let debt grow to the sky , like Jack's beanstalk , and all will be well. That's the plan in the UK , just ask SWL.

You could argue that Christianity is eclectic in the subject matter it addresses. But everything is related back to the Bible. We can look at the Theory of Evolution from a framework of the Theory of Creation.

Do you see a problem with that type of methodological approach? It may be fine as one way of viewing things, but should it be the only way?

Further, do you think that important insights and knowledge may be marginalised, and rather than gaining clarity on issues (for example starting from neo-classical or positivist assumptions which may bring in irrelevant information or inappropriate thought processes), we are losing it?

A gilt is an interest bearing time limited bond issued by the Bank of England.

A ten pound note is a non-interest bearing permanent bond issued by the Bank of England.

To purchase a new gilt you debit the account marked 'currency reserves' at the Bank of England and credit the account marked 'gilts outstanding'.

To settle a gilt you debit the account marked 'gilts outstanding' and credit the account marked 'currency reserves'.

Notice that both are balance sheet transactions and go nowhere near the P&L account.

Why does swapping numbers in a computer at the Bank of England worry SWL so much? Or is it really that the terms used 'debt' and 'print money' have psychological anchors in his own experience that politicians can use to manipulate an old man?

"Yes, MMT definitely agrees there are limits to real resources, and trying to go beyond full employment of them will cause inflation. Since government has an infinite number of keystrokes to spend, it can always win any bidding war against private uses for those resources. The result is runaway inflation. We agree.

"But selling bonds does not help! Bonds just mop up excess reserves. Even after buying the bonds, banks can continue to lend to borrowers who can continue to borrow and spend in an effort to win the bidding war against the government. Indeed, holding bonds provides good collateral against borrowing! And the bonds pay interest that can be used to raise the bids! So, yes, government spending can be so great it causes inflation—maybe hyperinflation—but that can occur with or without bond sales. Krugman is just wrong on this."

"this non-eclecticism in terms of excluding non-microfounded work is deeply problematic...But for me at least this as a methodological point, rather than anything associated with any school of thought."

But isn't it then a higher-level school of thought? Does it not function as a pervasive, near-invisible dogma that insists all economic analysis - and policy - must be framed in terms of market relations, consumerism and 'black box' ('foundational') preferences?

An insistence on making everything compatible with this kind of 'micro-foundations' may be seen as cementing the mythology of 'emergent order' that ignores the detail of obvious realities such as class solidarity/bounded competition, market manipulation, corporate collusion, 'supply-push' preference formation via marketing/advertising.

After all, there is little methodological sense in it. The supposed 'foundations' are not a set of individual-level psychological observations, and are not foundational in any sense, but rather abstract constraints on the type of models that are deemed acceptable. This seems clear enough, as a stylised fact, from a cursory inspection of the models, which far from including more variables (potential real-world inputs) than Lucas-criticised macro-economic models, include far fewer.

1. The notion of Pareto-improvement, for example, is tailor-made to apply to market transactions and to neglect anything else, with Pareto-optimaility - 'equilibrium' being functionally equivalent to no more than 'no market exchanges possible down this path'. The fact that Kaldor-Hicks improvement is used instead of Pareto-improvement shows how inadequete Pareto-i is for actual purposes - yet K-H, while effectively acting like a type of cost-benefit analysis, still keeps Pareto-i's market (+ liberal-market compensation) focus and accordingly restricts the range of outcomes that need to be, and that which may be, considered. The methodological reasons for using Pareto-improvements and Pareto-optimality' don't really hold much water - they are founded in conceptual dogma, not practical or epistemic constraints.

2. I think this is analogous, and related, to the points Wong ( http://semillero-hpe.wikispaces.com/file/view/Wong05+-+Foundations+of+Paul+Samuelson's+revealed+preference+theory.pdf ) tried to make in his critique of 'revealed' preference. Revealed preference privileges actual or potentially available market transactions as the sole indicator (or constituent) of preference - but the practical/epistemic constraints that supposedly motivate it are routinely ignored since a theortically usable conception of ordinal preferences requires going way beyond the very limited data any actual, situated, single market transaction would provide.

3. Perhaps the most glaring example of this false appeal to 'methodology' in such a way as to entrench idealised markets as the sole subject of policy and analysis is Walrasian market-clearing. This introduces a non-existent central planner to bring about the 'emergent' optimal allocation supposedly achieved by markets in equilibrium. The latter is of course reated as the only game in town on the basis that it supposedly effortlessly co-ordinates economic activity in a way that would supposedly be computationally impossible (a kind of epistemic/practical - methodological - consideration) for any latter day Stafford Beer to get anywhere near emulating. As, e.g., Axtell (http://econfaculty.gmu.edu/pboettke/workshop/archives/f05/Axtell.pdf ) points out, though:

"Walrasian markets in their Arrow-Debreu conception are an ideal type, in the terminology of the philosophy of science, a caricature of reality that abstracts from many details of real markets in order to provide a home for our intuitions and a point of departure for deeper exploration of market processes. Unfortunately, the embodiment of this ideal type in CGE software, especially when utilised for policy purposes, institutionalises a series of propositions that more behaviourally realistic and decentralised models reveal to be false, namely, that markets do not disperse wealth, yield allocations that are determined solely by preferences and endowments and are not history-dependent. Luckily, the unreality of this ideal type is given away by its computational intractability.

"In the end we advocate not the jettisoning of this useful abstraction but merely its circumspect use whenever focused on questions for which it has limited ability to adjudicate an appropriate answer, e.g., distributional issues, actual prices. But because policy-focused model deal always and everywhere with just these issues, a direct consequence of the results described above is to at least cast a pale on the utility of such analyses, if not to vitiate them altogether."

Note that Axtell himself seems to fall foul of a confusion - that 'Pareto optimality' has any salience - or indeed denotation - beyond being the terminating point of a set of transactions: "...when two equally efficient (i.e., Pareto optimal) market mechanisms having significantly different computational complexity are competing..." - this supposes that two Pareto-'optimal' distributions share a property of being 'efficient' (or otherwise desirable, even 'optimal') in something other than the highly-circumscribed Pareto sense. They needn't and almost certainly won't. Pareto 'efficiency' is an almost entirely uninteresting property of a distribution to anyone who has not been trained to focus on it.

In all these cases, a purely notional - illusory - methodological parsimony serves to focus attention on market transactions to the exclusion of any other possible mechanism. The supposedly 'hard' methodological constraints are no such thing, and (regardless of their actual aetiology) now function as a hegemonic 'school of thought' treated as purely technical and thus uncontroversial.

There is a lot here, and I only have time to be brief. You are quite right to be critical of Pareto optimality (or rather its misuse), as I have been. But of course there is a whole branch of economics that ignores it, and happily investigates alternative distributions. So again its how economists misuse the tool kit, often because of ideological motives, rather than any inherent problem with the toolkit. In short, I would much rather have heterodox critiques arguing their case from within, rather than being largely ignored on the outside.

Science was already well-established, yet the economic founding fathers were slow to realize that scientific standards and political popularity are different things.

“But he [A. Smith] had no such ambitions; in fact he disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter, 1994, p. 185)

But progressively economics looked rather retarded compared to the genuine sciences.

“The backward state of the Moral Sciences [i.e. political economics] can only be remedied by applying to them the methods of Physical Science, duly extended and generalized.” (Mill, 2006, p. 833)

Economists never really understood what science is all about but they understood quite well that they had to repackage their stuff in order to progress from the soap box to academia. This is how the greatest methodological simulation of all times started (Mirowski, 1995). It duly ended in what Feynman readily identified as cargo cult science.

Cargo cult science is defined as “The form is perfect. ... But it doesn’t work.” (Wikipedia)* Dilettantes always fall for the form.

How, then, do the genuine sciences work? “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

As a consequence, models that are found to be formally or materially inconsistent have to go out of the window. This Iron Rule of scientific methodology, though, had been tacitly suspended as Morgenstern reminded his colleagues “In economics we should strive to proceed, wherever we can, exactly according to the standards of the other, more advanced, sciences, where it is not possible, once an issue has been decided, to continue to write about it as if nothing had happened.” (1941, pp. 369-370)

Nothing has changed since the 1940s; logical and material inconsistency is simply filibustered away. Because economists never satisfied the standards of science they had to lower them successively to anything goes, pluralism, or eclecticism, that is, to the peaceful coexistence of false theories. This is why we have Walrasianism, Keynesianism, Marxism, and Austrianism -- and all of them are provably false.

Wren-Lewis sells abject failure as merit. The methodological fact of the matter is that economists have until this very day no idea of what the crucial difference between the elementary concepts income and profit is. As the Palgrave Dictionary summarizes “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10)**

In plain words this means that economists have no idea of the pivotal phenomenon of their discipline. Which means in turn that they have no idea of how the economy works. But they have a heap of incoherent and contradictory models. In economics, everything and the exact opposite has already been said and because of this, no matter what happens in the economy some economist has modeled it long ago or is in the very process of doing so. This is not how science works.

Economists are scientifically incompetent. All models, including all variants of DSGE, are false because they are based on an inconsistent definition of income/profit and take plain nonentities like equilibrium, constrained optimization or rational expectation into the axiomatic foundations.***

No scientist will ever accept Walrasianism, Keynesianism, Marxism, or Austrianism. These approaches are logically and/or empirically refuted. They cannot be enlarged or improved, only abandoned.****

Eclecticism is indeed desirable to make economics useful.Not necessarily useful for predictions, because human social reality can hardly be predicted: any prediction will influence its objects to evade the prediction, especially when predictions concern the satisfaction of their needs and wants.

Eclecticism does not square with science.Science requires systematic building of knowledge rather than combining elements from various 'buildings'.

The social status of economists and the power of their predictions to self-fulfill (to make people act as if they are true) require scientific status.

Mainstream economics is eclectic in only a very limited way.Not only because it doesn't integrate Marxian and post-Marxian economics (economics that takes collectives rather than individuals as analytical starting point).Another important limitation on its eclecticism is its market framework (supply/demand, production/consumption).Needs and wants are only partially satisfied in ways that can only be described by distinguishing supply of & demand for 'products'.Describing need & want satisfaction (only) in that way is more often than not limiting understanding.Belonging (organizing satisfaction of needs & wants collectively as it behoves 'us' to do so), hierarchy (organizing satisfaction of needs & wants in the way in which superiors require us to do so) and conviction (organizing satisfaction of needs & wants in the way we have been convinced/brainwashed to consider best) are (taken together) more important than dependence (organizing satisfaction of needs & wants on the basis of what others can supply us with).

"And just as his colleagues, when it really counts, Wren-Lewis shows what he is — a mainstream neoclassical economist fanatically defending the insistence of using an axiomatic-deductive economic modelling strategy. To yours truly, this attitude is nothing but a late confirmation of Alfred North Whitehead’s complaint that ‘the self-confidence of learned people is the comic tragedy of civilization." Wren-Lewis on macroeconomic eclecticism, Lars P. Syll | Professor, Malmo University.

Damn with faint praise eh! In that case, let's hear it for the heterodox "fanatics" http://www.amazon.co.uk/SACK-ECONOMISTS-disband-their-departments-ebook/dp/B00GS01GE0/ref=sr_1_1?s=books&ie=UTF8&qid=1452880781&sr=1-1&keywords=sack+the+economists

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time. In addition, I cannot publish comments with links to websites because it takes too much time to check whether these sites are legitimate.